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Saturday, May 31, 2014

The greatest economic puzzle in the budget is Tony Abbott's intention to
"deregulate" university fees in 2016. There's a lot more to it than
many people imagine.

Punters who make no profession of understanding
economics think fees will skyrocket. Advocates of the change, who think
they know more than the punters, say increases will be constrained by
competitive pressure.

The more economics you know, the less
certain you can be about how things will turn out. But you can make a
pretty persuasive case that, for once, the punters may be closer to the
truth than the advocates.

Abbott and his Education Minister,
Christopher Pyne, plan two main changes: the deregulation of fees and
changes to the HECS loan scheme. I'll leave the loan changes for another
day and focus on the fee changes.

At the same time as it permits
unis to set their own fees for undergraduate courses, the government
will cut its contribution towards the cost of courses by an amount that
averages 20 per cent. It will then reduce the annual indexation of its
contribution, switching to the consumer price index, which doesn't rise
as fast as the unis' wages and other costs.

So the government's
primary motivation is clearly to shift more of the cost of universities
from itself and onto students. The 20 per cent cut will give the unis an
immediate and pressing reason to use their new freedom to increase the
fees they charge, and the less-generous indexation will maintain the
pressure for further increases.

Even so, the man who recommended
that unis be allowed to set their own fees, Andrew Norton, is confident
the initial increase will be no more than $6000 a year, taking annual
fees to between $12,000 and $16,000, depending on the course.

The
government is confident its changes will increase competition between
the unis, leading to greater diversity, innovation and quality, and
giving us "a world-leading higher education and resource system".

The
simple model of how markets work taught in introductory economics
courses leaves may people with excessive faith in the ability of market
competition to foster increased efficiency, constrain price increases
and ensure customers get high quality.

Its promises are based on a
host of limiting assumptions, which usually don't apply. It assumes a
very large number of small firms selling a homogeneous product to buyers
with "perfect knowledge" of the quality and other characteristics of
what they're buying.

In the tertiary education "market", however,
we have a relatively small number of large and larger organisations,
selling differentiated products of uncertain quality. We have oligopoly
rather than "perfect competition".

We know oligopolists compete,
but usually try to avoid competing on price rather than marketing. They
have a degree of pricing power and their competition takes the form of
"rivalry" - focusing on the behaviour of competitors rather than the
needs of customers.

It's misleading to describe giving unis
freedom to set their own fees as "deregulation". Indeed, it's silly to
imagine higher education is anything like a market. It's "firms" are
owned by the state governments and highly regulated by the federal
government. All its courses still have to be accredited by the feds
which, they claim, guarantees that quality standards won't fall.

Even
the unis' freedom to raise their fees - which the next government could
reverse - comes with a string attached: fees charged to local students
may not exceed those charged to overseas students.

There's no
profit motive. And, as any academic will tell you, unis are highly
inefficient, bureaucratic organisations dominated by administrators.

The safest prediction is that giving unis greater revenue-raising ability will lead to them employing more administrators.

How
can uni fees be regarded as a "price" in the textbook sense when people
are lent the money to pay the price under a concessional loan they
won't have to repay for years?

In effect, universities have a
government-regulated monopoly over a product that gives young people
access to the country's highly paid jobs. What will they do when the
price jumps - abandon all ambition? Demand seems highly "price
inelastic" - unresponsive to price changes.

Our unis are protected
from import competition by the high fees other countries charge foreign
students. Within Australia, unis enjoy a degree of geographic monopoly.
Sydney and Melbourne unis don't really compete for students. Living
costs can be high if you move to a regional uni.

The sandstone
unis will be able to charge a premium that reflects their higher status,
more central locations and lovely campuses. In a normal market, other
unis would charge less than the big boys.

The simple model assumes
consumers ensure prices reflect differences in quality. But where it's
hard to judge the quality of a product before you try it, many people
reverse the causation and assume the higher the price, the higher the
quality. This gives lower-quality producers an incentive to charge high
prices.

In the early noughties, the Howard government allowed unis
to raise their fees by 25 per cent. One small uni decided not to do so.
It found its applications from new students actually fell. So the
following year it put its fees up like all the others and its
applications recovered.

In Britain, the Cameron government allowed
unis to raise the 3000 pound annual fee they charged local students up to a
limit represented by the 9000 pound fee charged to foreign students. Almost
all of them took the opportunity to raise their fees to the maximum
allowed. Applications dropped by 9 per cent in the first year, but rose
in subsequent years.

On the basis of all this, my guess is the
sandstone unis will raise their fees a long way and the less reputed
unis won't be far behind them. Their notion of competition will be to
make sure no one imagines a lesser fee than the big boys is a sign of
their lesser quality.

Wednesday, May 28, 2014

It has been easy for older people to see themselves as particular
victims of this budget. And I confess I never expected to see any
government courageous enough to pick on Grey Power the way Tony Abbott's
has. In his efforts to get people into the workforce, however, it's
carrots for the old and sticks for the young.

A major goal of this
budget is to increase everyone's ability to contribute to the economy:
"everyone who can contribute should contribute." Contribute doesn't mean
paying a higher rate of tax, of course, but taking a paid job.

"This
budget is about shifting our focus from entitlement to enterprise; from
welfare to work; from hand-out to hand-up." Don't you feel better
already?

To this end, the budget cuts benefits to sole parents and
stay-at-home mums, reviews the assessment of some younger recipients of
the disability support pension and imposes "compulsory activities" on
recipients under 35, cuts the benefit received by unemployed people aged
22 to 24 from the dole to the youth allowance, imposes a waiting period
for benefits of up to six months on people under 30, reintroduces Work
for the Dole and introduces a "restart" payment of up to $10,000 to
employers who take on job seekers aged 50 or over who have previously
been on benefits, including the age pension.

Get it? Older people
want to work, but suffer from the prejudice of employers, so they're
helped with a new and generous subsidy to employers, whereas the young
don't want to work when they could be luxuriating on below poverty-line
benefits, so they're whipped to find a job by having their benefits cut
and their entitlement removed for six months in every year until the
lazy loafers take a job.

Just how having their benefits reduced or
removed helps young adults afford the various costs of finding a job -
including being appropriately dressed for an interview - the government
doesn't explain.

But anyone who can remember the controversial
statements Abbott used to make as minister for employment in the late
1990s will know he has strong views about the fecklessness of youth and
the need for a pugilistic approach to their socialisation.

Consider
this from a budget glossy spin document: "The government is reinforcing
the need for young Australians to either earn or learn. The changes
will prevent young Australians from becoming reliant on welfare.

"Because
we want new jobseekers, especially those leaving school and university,
to actually look for work, income support will only be provided once a
six-month period of job hunting has been completed."

And if it
doesn't work the first time, give them six months on Work for the Dole,
then keep repeating the dose until it does. If that doesn't get 'em off
their arses, nothing will.

Really? Young Aussie adults are that
lazy and lacking in aspiration? No shortage of jobs, just a shortage of
effort that a monetary boot in the backside will soon fix?

The
notion that our young people should either be "earning or learning" has
intuitive appeal, but a moment's reflection shows it can easily be taken
too far.

How does it help to starve a youngster to the point
where they're prepared to undertake some pointless training course? Is
it really smart to take a university graduate who's having a few months'
wait to find a suitable job and force them into a taxpayer-funded
course on driving a forklift truck?

We've been hearing a lot
lately about the difficulty older people have in finding re-employment.
I'm sure there's much truth to it, and the government has acted. But we
hear much less about the way the young suffer whenever times are tough
and employers become reluctant to hire.

Everyone thinks a policy
of reducing staff numbers by "attrition" is a relatively benign response
to an economic slowdown. Big staff layoffs are avoided. But few
remember this transfers the burden from people already in jobs to those
seeking jobs, particularly those leaving education. The annual
entry-level intake is the first thing to go.

Before Abbott turned
up with his punitive solution to a problem few people realised we had,
the Brotherhood of St Laurence began campaigning to raise public
awareness of rising youth unemployment.

Unemployment among those
aged 15 to 24 shot up in the recession of the early '90s, reaching more
than 380,000 in October 1992. But by August 2008 it had fallen to less
than 160,000. That was immediately before the global financial crisis.
Since then it has climbed back to about 260,000.

The rate of
unemployment among 15- to 24-year-olds is 12.5 per cent, more than
double the overall rate. This means they account for more than a third
of the unemployed.

And it's not just more of them: over the past
five years the average duration of unemployment for young people has
risen from 16 weeks to nearly 29 weeks.

The funny thing is, the
executive director of the Brotherhood, Tony Nicholson, doesn't find much
evidence these people are happy to live on the dole forever. "They
aspire to a mainstream life - to have a home, to have some sense of
family, to belong. A key part of that belonging is the desire to have a
paid job."

Maybe the problem is not enough jobs rather than not
enough effort. If so, putting them on a starvation diet may not do much
to help.

Monday, May 26, 2014

According to Treasury secretary Dr Martin
Parkinson, the budget is replete with ''structural reforms''. According
to his boss Joe Hockey, it will ''drive the productivity required to
generate economic growth''. Sorry, not convinced.

As a
vehicle for micro-economic reform, the budget gets less impressive the
more I study it. Parkinson seems to be referring to reforms to the
structure of the budget itself, which will build ''fiscal resilience''
over the coming decade.

That's true enough in terms of
returning the budget to a sustainable surplus (business cycle
permitting). In the process, however, the budget cuts will do little to
raise the efficiency with which the government performs its own tasks,
nor the efficiency of its interaction with private industries.

Rather
than making what the government does more cost-effective, it just stops
doing as much. It makes the federal government smaller, but not better.
It's a giant exercise in cost-shifting: to people on pensions, to the
young jobless, to university students, to the sick and, to the tune of
$80 billion, to the states.

It's about crude spending cuts,
not about using science to improve efficiency. Does anyone seriously
believe imposing yet another temporary increase in the ''efficiency
dividend'' on the public service will lead to cost savings without any
decline in the quantity and quality of services provided to the public?

Hockey's
talk of productivity improvement seems mainly a reference to the
budget's increased spending on public infrastructure. I guess we
shouldn't complain about the Liberals' belated recognition that adequate
infrastructure increases the productivity of the private sector - it
would be news to Peter Costello - but the money does need to be well
spent to maximise the benefit.

Monuments and
pork-barrelling do little for productivity. And I'm not convinced the
Libs' bias - federal and state - towards expressways and against public
transport is the way to get the greatest productivity gain.

Next
exhibit on the micro-reform list would be the deregulation of
university fees. The claim that this will unleash competition and so
make the tertiary education ''industry'' a lot more efficient is so
debatable I'll leave it for another day.

Along with Tony
Abbott (St Ignatius, Riverview) and Christopher Pyne (St Ignatius,
Adelaide), Hockey (St Aloysius, Sydney) has repudiated the Gonski
reforms which would have put federal grants to schools on a needs basis.
He's left grants to private schools unreformed and unmeans-tested,
while grants to public schools will cover an ever-declining share of
their costs.

Leaving aside questions of fairness (and
partiality), this is a micro-reform negative. Adjusting grants to
reflect students' disabilities would have done much to increase the
skills, employability and workforce participation of kids at the bottom
of the distribution. It could have been done more cheaply than Labor
planned by reducing grants to privileged schools to compensate.

Medical
services account for 9.5 per cent of gross domestic product, meaning we
have few industries that are bigger, even though much of the industry
is government-owned or heavily government-subsidised.

There
is plenty of room for the reform of excessive schedule fees for certain
procedures, perverse incentives and overservicing, particularly by the
corporate sausage-machines that have been permitted to take over so much
of general practice.

The doctors' union could be obliged
to allow nurses and other health professionals to perform many routine
procedures. Many evidence-based reforms could be implemented to reduce
waste and increase productivity in public hospitals without reducing the
quality of care.

Much could be done to reduce the cost of
the pharmaceutical benefits scheme by taking a tougher line with foreign
drug companies over generics and the ''evergreening'' of patents, not
to mention the chemists' union.

Paradoxically, overseas
experience says greater efficiency can be achieved by imposing a cap on
the growth in total scheme spending, thus requiring medical
representatives to make harder choices about which new drugs are really
worth listing.

So what was done? Hockey introduced a $7
charge on GP visits, tests and scans that will be costly to collect and
will get at the corporate overservicers by hitting every patient and
will discourage the poor from seeing the doc, whacked up an already high
co-payment for pharmaceutical scripts and slashed projected grants to
public hospitals.

For good measure, Hockey stopped wasting
money on all that preventive medicine stuff. Brilliant. Must have taken a
genius to dream all that up.

Finally, ''corporate
welfare''. The foreshadowed toughness didn't materialise, save for a
brave decision to take the ethanol subsidy from a very generous
political donor. But the opportunity for sharing the pain - and doing
much to force change on a lot of corporate ''leaners'' - was missed.

Saturday, May 24, 2014

You have to look hard, but there are two logical sleights of hand in Joe
Hockey's fiscal policy, as dutifully expounded by his Treasury
secretary, Dr Martin Parkinson, in his speech this week.

Parkinson
makes three important points that have tended to be lost in all the
furore over Hockey's choice of victims in his efforts to get the budget
back on track. I'll take issue with the last two.

The first is the
"measured pace of fiscal consolidation". ("Fiscal" is a fancy word for
the budget and "fiscal consolidation" is a euphemism for the spending
cuts and tax increases needed to get the budget back into surplus.)

Parko's
point is that, though Hockey has announced a host of decisions to
improve the budget balance, many of them don't start for a year or three
and the rest don't have much effect for a few years.

Relative to
the estimates we were given in the mid-year budget review just before
Christmas, the effect of the measures announced in the budget, plus any
revisions to the economic forecasts, is expected to reduce the deficit
for next financial year by just $4 billion (relative to nominal gross
domestic product of $1630 billion).

The expected improvement in
the second year, 2015-16, is just $7 billion, with the same improvement
the year after. Not until the fourth year, 2017-18, is a big improvement
of $26 billion expected to bring the budget back almost to balance.

See
how gentle it is? Why so "measured"? Because the economy is still
relatively weak - "below trend", in the jargon - and is expected to stay
relatively weak for another year or two as spending on the construction
of new mines and gas facilities falls much further.

So Hockey
delayed the effect of most of his measures until he was confident the
economy could absorb the shock without falling in a heap. This is
exactly what the Brits and others didn't do - which is why it's both
wrong and ignorant to refer to Hockey's measures as a policy of
"austerity".

Parko's second point is that the budget measures
involve a "compositional switch" in government spending. Hockey's cuts
are aimed at "transfer payments" (transfers of money) that flow into
consumer spending.

At the same time, however, he's actually
increasing investment spending on new infrastructure by almost $12
billion over five or six years. Five billion of that is his "asset
recycling initiative", which offers the state governments a 15 per cent
incentive to sell off some of their existing businesses and use the
proceeds to build new infrastructure.

So the incentive should lead
to a lot more infrastructure spending than would otherwise have
occurred. And, on top of that, we know investment spending has a higher
"Keynesian multiplier" than consumption spending.

This change in
the mix of government spending is happening by design, intended to help
fill the vacuum left in the engineering construction sector by the sharp
fall in mining construction. More proof Hockey is no economic wrecker.

But
this year's budget papers include a new section giving the split-up of
total government spending between "recurrent" spending (cost of keeping
the show going for another year) and spending on investment, something
forced on Hockey as part of a deal with the Greens to remove Labor's
(silly) cap on total government borrowing.

What past governments
haven't wanted to tell us is that about 9 per cent of their annual
spending is capital, not recurrent. For the coming financial year this
is $36 billion. More than half of this is capital grants to the states,
20 per cent is defence equipment and 14 per cent is building the
national broadband network, leaving 11 per cent on the feds' own capital
purchases.

The budget papers confirm the new government's
commitment to the "medium-term fiscal strategy" first set down by the
Howard government to "achieve budget surpluses, on average over the
course of the economic cycle".

This is a good formulation, with
one, now-more-salient weakness: its failure to distinguish between
recurrent and capital spending. Hockey and his boss keep saying the
budget has to be returned to surplus because we're "living beyond our
means" and leaving the bill for our children.

That's true only to
the extent we continue borrowing to cover recurrent deficits. To the
extent we borrow to help cover the cost of infrastructure - which will
deliver a flow of services extending over 30, 40 even 50 years - we're
not living beyond our means (any more than a family that borrows to buy
its home is) and not treating the next generation unfairly.

So
setting yourself the goal of paying for all your infrastructure
investment and having the government end the cycle with an ever-rising
bank balance is fiscal conservatism gone crazy.

The second of the
government's fiscal sleights of hand comes with Parkinson's third point:
Hockey's plan involves creating "headroom for tax cuts".

In
projecting government spending and revenue over the coming decade, the
government has resolved to impose a cap on the growth in tax collections
at 23.9 per cent of GDP. And government spending has been cut hard
enough to accommodate that cap while still producing ever-growing
surpluses.

Why? Because, we're told, "fiscal drag" (bracket creep)
can't be allowed to run on forever. It would push low- and
middle-income-earners into much higher tax brackets ("marginal tax
rates") which would be both economically damaging and politically
infeasible.

Fine. We've had to rely on years of bracket creep to
correct the irresponsibility of Peter Costello's eight tax cuts in a
row, but this can't go on for ever.

Did you see the sleight of
hand? You don't need to cap tax collections just to counter bracket
creep in income tax. Hockey is making room for much bigger tax cuts than
that. And there's zero guarantee the chief beneficiaries of those cuts
will be the low- and middle-income-earners who suffered most under the
creep.

Wednesday, May 21, 2014

Do you like paying tax? No, I thought not. Well, I have good news. The
harsh measures in last week's budget were directed towards one
overwhelming objective: getting the budget back into surplus without
increasing taxes to do it. Indeed, Joe Hockey is working towards the day
when he can start cutting income tax.

If you hadn't quite realised
that, you could be forgiven. You've been unable to see it because of two
distractors: the deficit levy and the resumed indexation of fuel
excise.

But the levy is just a temporary pin-prick to the top 3
per cent of taxpayers who will pay it. And the price of petrol will rise
by only about 1 cent a litre per year. The effect of the excise
increase will be dwarfed by the ups and downs in the world price of oil.

The
catch is this: you may hate paying tax, but don't be too sure Hockey's
efforts to avoid tax increases and eventually make room for income-tax
cuts will leave you ahead on the deal.

Why not? Because to avoid
increasing taxes - and avoid cutting the big tax breaks some people
enjoy - Hockey has concentrated on cutting back all manner of government
spending. And most people - maybe all families bar the top 10 per cent
or so - have more to lose from cuts to government spending made, than
they have to gain from tax increases avoided.

That's particularly
true when Hockey's efforts to cut government spending take the form of
tightening means tests, moving to meaner rates of indexation and
introducing or increasing user charges.

Don't think just because
you voted for the Coalition Hockey is looking after you. It works out
that low income-earners - generally the old, the young and the
unemployed - are heavily dependent on government spending, and genuinely
middle income-earners with dependent kids are significantly reliant on
government spending.

Only high income-earners who've already been
means-tested out of eligibility for most programs (e.g. me) have little
to lose from Hockey's cuts. That's the reason for the deficit levy.
Without it, it would have been too easily seen that high income-earners
weren't doing any of Hockey's "heavy lifting".

Indeed, too many
people might have twigged that the whole exercise was designed to have
high income-earners as its chief beneficiaries. The spending cuts are
permanent and many of them save more as each year passes. But the
deficit tax is temporary.

Hockey wants us to believe he had no
choice but to do what he did. I accept he had to get on with bringing
the two sides of his budget back into balance, but he had a lot of
choice in the measures he took to bring that about.

He chose to
focus on cutting three big classes of government spending: health,
education, and income-support programs (pensions, the dole and family
tax benefits). Not by chance, these are the programs of least importance
to high income-earners.

And while slashing
away at health, education and income support, he was also busy
abolishing the carbon tax, the mining tax paid largely by three huge
foreign mining companies, cutting the rate of company tax by 1.5
percentage points and exempting federal grants to private schools from
his education cuts.

Hockey will tell you his net cuts to health,
schools and age pensions don't actually take effect until 2017, after
the 2016 election. This is the basis for his claim not to have broken
Abbott's election promises. (Remember, all the proceeds from his cuts
and charges in health care will go into the new medical research future
fund.) It's largely true - though only for Abbott's "core" promises.

Even so, Hockey's most objectionable changes are the punitive treatment
of the young jobless and the attack on Medicare's principle of
universality. The measures that will do most harm to the Liberal
heartland (including the children of high income-earners) are the
changes to HECS and deregulation of university fees.

Some people
are referring to Hockey's $7 patient co-payment for GP visits, tests and
scans as a tax. This is quite wrong. It's precisely because it isn't a
tax that it has been introduced. It's a user charge: use the service,
pay the charge. By contrast, taxes are amounts you pay the government
that bear no direct relationship to what you get back.

High
income-earners want more user-charging (for pharmaceuticals as well as
GP visits) because they're no great burden to the highly paid, but they
reduce the need for higher taxes. They reduce the cross-subsidy from the
rich to the poor.

I must warn you, however, of the one glaring
exception to high income-earners' insistence that tax increases be
avoided at all cost (to other people). The one tax increase they lust
after is a rise in the goods and services tax.

Why? Because they believe
it will be part of a deal in which the higher GST paid by everyone is
used to pay for another cut in the rate of company tax plus a cut in the
top rate of income tax.

Monday, May 19, 2014

The more of the budget's fine print I get through, the less impressed I am. It's not a budget so much as a flick-pass.

On
its main goal of returning to surplus, you can accept the plausibility
of its projections that budget balance will achieved by 2018-19 without
being terribly impressed by the quality of its claimed "structural"
savings.

The policy changes proposed yield savings over the four
years to 2017-18 totalling $38 billion (on an accruals basis). Contrary
to all the government's rhetoric, almost a quarter of these savings come
from increased tax collections.

But get this: fully 46 per cent
of the total savings come in the fourth year. Until then, net savings
are quite modest. There are various reasons for this delay. One is
political: Tony Abbott is keeping some core promises by not breaking
them until after the 2016 election.

Another is macro-economic: Joe
Hockey is delaying the big cuts until he's confident the economy will
be strong enough to absorb them. Yet another is that the Labor
government's back-end loading of its new spending programs meant some
very big bills fell due in the year beyond last year's forward estimates
(where they were harder to see).

But there's one more reason:
2018 is the first year when the expiry of various agreements allows the
feds to really start screwing the states on grants for public schools
and public hospitals. From then on, grants will be adjusted only in line
with inflation and population growth.

This means almost all of
Hockey's cumulative savings of more than $80 billion on payments to the
states for schools and hospitals over the decade to 2024-25 occur beyond
the forward estimates.

Before the election, Abbott and Hockey
claimed repeatedly to be able to return the budget to surplus by
eliminating waste. In truth, they've identified and eliminated little or
no genuine waste.
Rather, they've defunded worthy causes (grants
to charities and cultural activities, overseas aid), imposed new user
charges (Medicare benefits, the real interest rate on HECS), whacked up
existing user charges (pharmaceutical benefits, university fees) and
tightened up means-testing (family tax benefit B).

But a lot of
the longer-term savings come from lowering the indexation of payments
from a wage-related index to the consumer price index. In the case of
pensions, this will cause the relative value of pensions to fall
continuously over time, pushing the aged and disabled below the poverty
line.

In the case of payments to the states for schools and
hospitals - whose main cost is wages - it leaves an ever-widening gap
the states wouldn't have a hope of covering by increased efficiency,
only from other revenue sources. (The cost of medical supplies grows
much faster than the CPI.)

As well as meaner indexation, there's a
lot of two or three-year pauses in indexing thresholds or payments
(family tax benefit, some medical benefits schedule fees, the Medicare
levy surcharge, the private health insurance rebate, grants to local
governments).

Note, these are largely temporary savings to the
budget, though there's some ongoing saving because of the lower base (in
real terms) established before indexation is resumed.

And note
this. Hockey justified his exclusion of the cost of superannuation tax
concessions from his efforts to curb the allegedly unsustainable growth
in the cost of population ageing by saying tax expenditures would be
considered as part of the coming review of taxation. In truth, he did
fiddle with tax expenditures when it suited him (the mature age worker
tax offset and the dependent spouse tax offset).

See what this
means? If the Coalition ever does get around to reforming the
concessional tax treatment of super, capital gains and negative gearing -
each benefiting mainly high income-earners - it will do so not as part
of the effort to balance the budget, but as part of a revenue-neutral
tax reform package where the savings are used to (I bet) cut the top tax
rate, with increased collections from the GST shared between the
premiers and a lower rate of company tax.

The budget was a giant
attempt to get back to surplus solely by cutting spending and not
increasing taxes. It failed. Not so much because of the temporary
deficit levy or the resumption of indexing the fuel excise, but because
the cumulative $80 billion saving from short-changing the states on
schools and hospitals - almost a quarter of the total saving - will have
to be covered by increased state taxation.

A tax increase
flick-passed to the states is a tax increase avoided? Any serious
increase in state tax revenue would have to be made possible by the
feds, in any event.

Saturday, May 17, 2014

The
consumerist question about this week's budget is: how did it affect my
pocket? The egalitarian question is: was its treatment of people at the
bottom, middle and top reasonably fair? But the macro-economic question
is: how will the budget affect the economy?

We know the economy has
been, and is expected to continue, growing at below its medium-term
trend rate of about 3 per cent a year, the rate that keeps unemployment
steady. So will the budget help to speed things up or slow them down? In
the economists' jargon, will its effect be "expansionary" or
"contractionary"?

It may seem a simple question, but economists
have various ways of attempting to answer it. One outfit asking itself
this question is the Reserve Bank. The Reserve will take account of the
budget's effect - along with various other factors' effects - on the
strength of demand in the economy in making its monthly decisions about
whether to raise, lower or leave unchanged the instrument it uses to
affect the strength of demand, the official interest rate.

In
making that assessment the Reserve takes a very simple approach: in what
direction is the budget balance expected to change between the present
financial year and the coming financial year that starts in July? And
having determined the direction of the change, how big is it? Obviously,
the bigger it is, the more notice we should take of it.

Taken at
face value, the answers to those questions aren't ones most people would
be pleased to hear. Joe Hockey is expecting a budget deficit of $49.9
billion in the financial year just ending and a deficit of $29.8 billion
in the coming year.

That's an expected improvement of $20.1
billion - which may please those people who think getting the
government's deficits and debt down as quickly as possible is the only
thing that matters, but would worry most business people and economists.

Why?
When governments spend more in the economy than they take out of it in
tax collections - that is, run a deficit - they're contributing to the
net demand for the production of goods and services that keeps the
economy growing and increasing employment opportunities. Which, when
private demand is weak, is a good thing.

(It would be a different
matter if private demand were strong and the additional demand from the
public sector was adding to inflation pressure.)

So the expected
reduction of $20.1 billion in the budget's net addition to demand will
have a contractionary effect which, taken by itself, will tend to make
the economy grow even more slowly. And since the budget papers imply
nominal gross domestic product will be $1632 billion in 2014-15, a $20.1
billion change represents 1.2 per cent of GDP - making it highly
significant.

Oh dear. Doesn't sound good. But, as I say, this is
taking the budget figures at face value - always unwise in economics.
What's more, simply focusing on the direction and size of the expected
change in the budget balance is a bit simplistic.

For a start,
Hockey inflated the old year's deficit by choosing to make a payment of
$8.8 billion to the Reserve Bank. This is just the government moving
money between its pockets; it has no effect on demand.

If you
ignore the one-off payment to the Reserve, the expected improvement in
the budget deficit falls to $11.3 billion, which is equivalent to 0.7
per cent of GDP - but that's still a quite significant degree of
contraction.

But here's where we start getting tricky. When you
imagine that reducing the budget deficit by $1 will therefore reduce
nominal GDP by $1, you're implicitly assuming that whatever the
government does to bring that $1 reduction about won't have any effect
on the behaviour of people who've had their benefits cut or their tax
increased.

In the economists' jargon, you're assuming a
"multiplier" of 1. In 2009, however, the Organisation for Economic
Co-operation and Development published estimates of the multiplier
effects of changes in various classes of government spending and
taxation by the Australian government.

It found, for instance,
that increased government spending on building new infrastructure would
have a multiplier of 0.9 in the first year (and 1.3 in the second year,
as the increased spending by the government prompted the eventual
recipients of that money to increase their own spending).

By
contrast, it found that, on average, an increase in government spending
on "transfers to households" (such as a cash splash) had a multiplier of
just 0.4 in the first year, rising to 0.8 in the second year.

Why?
Because a lot of people would hang on to the money (save it, or use it
to reduce their debts) rather than spend it, particularly at first.

This
explains why the OECD's multiplier for a cut in income tax is only 0.4 -
people would save most of it. Similarly, an increase in income tax
would reduce consumer spending by only 60 per cent of the increase
because some people would cut their rate of saving to "smooth" their
consumption.

The OECD's various multipliers for Australia range
from 0.3 to 1.3. If we use a narrower range closer to the middle of that
range - 0.6 to 0.9 - and apply these multipliers to the 0.7 per cent of
GDP we calculated earlier, we get an estimated negative impact on GDP
of between 0.4 and 0.6.
This suggests the budget's negative effect on demand won't be too terrible.

And
note this: most of the expected improvement in the deficit in 2014-15
comes from an expected improvement in the economy (more people paying
more tax; fewer people needing assistance) rather than from all the
tough changes Hockey announced on Tuesday night.

The lion's share
of the budget savings don't come until 2017-18. Why? Partly for
political reasons but also because, as he's long been saying, Hockey
didn't want to hit the economy while it was down.

Wednesday, May 14, 2014

This budget isn't as bad as Labor will claim and the Liberal heartland
will privately think. It's undoubtedly the toughest budget since John
Howard's post-election budget in 1996, but it's hardly austerity
economics.

I give Joe Hockey's first budgetary exam a distinction on
management of the macro economy, a credit on micro-economic reform and a
fail on fairness.

Although Hockey has laboured hard to ensure few
sections of the community escape unscathed, the truth is most of us
have been let off lightly.

Only those people right at the bottom
of the ladder have been hit hard - unemployed young people, the sick
poor and, eventually, aged and disabled pensioners - but who cares about
them? We've been trained to worry only about ourselves, and to shout
and scream over the slightest scratch.

Someone in the top 4 per
cent of taxpayers on $200,000 a year will be wailing over the extra
$7.70 a week they'll be paying in tax. A single-income couple with kids
will be losing a lot more than that, while someone under 30 denied the
dole for the first six months will lose $255 a week.

And everyone
will be angry about the resumption of the indexation of fuel excise, so
worked up they forget it will raise the price of a litre of petrol by
about one cent a year.

Anyone surprised and shocked by the budget
can be excused only if last year's election was their first. Any
experienced voter who allowed themselves to be persuaded that "Ju-liar"
Gillard was the first and last prime minister ever to break an election
promise should pay their $7 and ask a GP to check for amnesia.

If
you thought a man who could promise "no surprises, no excuses" was a man
who could be trusted to keep his word, more fool you.

Any
experienced voter who didn't foresee that changing the government would
mean this year's budget was a stinker, isn't paying enough attention.

Labor
supporters want to believe that because Hockey and Tony Abbott are
exaggerating about a "budget emergency" and "tsunami of government
spending", we don't really have a problem. They are refusing to face
reality.

After running budget deficits for six years in a row, we
faced the prospect of at least another decade of deficits unless Hockey
took steps to bring government spending and revenue back together.
Failure to make tough decisions wouldn't have turned us into Greece, but
since when was that the most we aspired to?

This budget is
Abbott's admission that his claim to be able to balance the budget
without increasing taxes was no more than wishful thinking. The Liberal
heartland, however, schooled for years to give its selfishness free
rein, is having trouble facing this reality.

Hockey's problem was
that, with the economy weak and with big declines in spending on mining
construction still to come, sharp cuts in government spending or big
rises in taxes could have slowed the economy to a crawl.

This is
why some of the biggest savings he announced - particularly on the age
pension - have been timed not to take effect until 2017. It's also why
he put so much emphasis on increasing spending on infrastructure,
particularly by the states.

The economy is expected to be a lot
stronger by the time Tuesday's measures take full effect. This carefully
measured approach is what wins Hockey high marks for macro-economic
management.

He claims his reforms will improve the economy's
performance. His best measures along those lines are the increased
competition between universities, the concessional loans to TAFE
students, the loans to encourage youngsters to complete their
apprenticeships and the grants to encourage employment of people over
50.

But some measures are likely to make things worse rather than
better. The $7 patient co-payment for GP visits and tests is certainly
likely to discourage visits - more by the poor than the rest of us - but
if it dissuades people from seeking help until their medical problems
are acute it may end up costing the taxpayer more than it saves.

The
planned tighter means-testing and much less generous indexation of
pensions will be defensible only if the planned review of the tax system
leads to big reductions in the superannuation tax concessions going to
retirees far too well off to get the pension.

Monday, May 12, 2014

If you needed any convincing Labor is a party entirely adrift
from its supposed values and purpose, given over now to politicking,
expedience and opportunism, just wait for its reaction to Tuesday's
budget.

It will vehemently oppose Joe Hockey's deficit levy - no
matter how watered down it is by then - and his intention to resume
indexing the petroleum excise on the basis of no stronger argument than
that they're broken promises.

These are two measures Labor should
strongly support if it's sticking to its principles - one that makes the
tax system fairer and one that supplements the carbon tax in fighting
climate change.

If Labor were truly the social democrat,
progressive party it wants us to think it is, it would advocate and
fight for bigger government. Bigger not for its own sake, but because
there are still many much-needed services and assistance yet to be
provided, with governments best placed to provide them.

As we
know, Labor can always think of new ways to spend money - the National
Disability Insurance Scheme and the Gonski education reforms, for
instance - but when it comes to raising sufficient revenue to cover the
cost of these genuinely worthy causes, Labor's courage deserts it.

Its
conservative critics accuse it of being a big-spending, big-taxing
party but, in truth, it's a big-spending, low-taxing party - which can
never understand why it has so much trouble balancing budgets.

Labor
will carry on about Tony Abbott's ideologically driven plans to destroy
the universality of Medicare, but when the scheme's cost grows strongly
because the nation wants to take advantage of every new, expensive
advance in medical technology, the very initiators of Medicare lack the
commitment to do or even say the obvious: if you want better healthcare
you have to pay more tax.

You'd think that, lacking the courage of
its convictions, not having the guts to raise taxes (the proceeds from
the carbon tax and the mining tax were immediately given back, mainly as
lower taxes), Labor would be delighted when its opponents did have the
courage to stare down the voters' disapproval.

But no, Labor's
commitment to principle is now so weak it can't resist the temptation to
exploit the unpopularity of an opponent implementing good policy.

By
now I can hear the Laborites' plaintive cry: We're only doing what
Abbott did! My point, exactly. The party that always claims the high
moral ground has descended to the point where its highest claim is:
we're no worse than Abbott.

Labor's further descent into political
game-playing since it returned to opposition is proof that Abbott is
the outstanding politician of his era. The man could not only turn his
own side into a party of climate change-denying punishers of boat people
and even Australian poor, he can inveigle his opponents into becoming a
party than stands for nothing. Getting your own back isn't a policy
that much appeals to Australian voters. Nor is opposing everything.

If
Labor combines with the Greens to block Abbott's two tax measures in
the Senate, it will be doing him a favour: I tried to make the budget
fair, but Labor stopped me. So you won't have to vote against me after all.

By
blocking a progressive tax change Labor would force the government to
rely more heavily on bracket creep which, because of the strange shape
of the tax scale Labor left, will now be highly regressive. Then it will
be on to opposing any change in the goods and services tax because
Labor is far too principled to support a regressive tax.

Speaking
of the Greens, they've gone from naive purity (knocking back Kevin
Rudd's original carbon pollution reduction scheme because he'd have no
choice but to come back with a better one) to abject populism in
opposing measures that make the tax system both fairer and more
efficient.

Labor's professed outrage over Abbott's breaking of
promises is utterly confected. I mean, have you ever known Labor to
break a promise?

The supposed sanctity of election promises is a recipe for bad government.

No
one who cares about good policy - as opposed to seeing their side get
back to power - would think it smart to hold politicians to promises
they should never have made, or which have been overtaken by events.

Much better to do something damaging to the economy or unfair to particular classes of people than to break a promise? Hardly.

The
sensible answer isn't to insist on promises being kept come hell or
high water, it's to insist politicians stop making promises they aren't
certain they can keep.

Saturday, May 10, 2014

If you want to see a classic example of selfishness posing as high
principle, look no further than the fuss big business's high
income-earners are making over the deficit/debt levy/tax expected to be
imposed in Tuesday's budget.

Jennifer Westacott, of the Business
Council of Australia, said "raising Australia's already high dependence
on personal income tax will place an increased burden on workers [note
that word] and could weigh down an already sluggish economy. If we are
serious about lifting our productivity and competitiveness, we should be
lowering taxes, not increasing them."

Dale Alcock, of the home
builder ABN Group, said the tax could dissuade people from working hard
to earn more. The "government needs to get its own house in order first
and get its government departments working efficiently. Once you've done
that, then come back and talk to us."

Sound like a convenient
argument to you? Now try this for logic: he would prefer an increase in
the rate of the goods and services tax that, by its nature, raised
revenue from wealthy, high-consuming individuals, as opposed to a
class-based deficit tax.

So a tax increase paid by everyone would
be preferable - why? Would it be fairer? Better for the economy? - to a
tax limited to high income-earners.

Innes Willox, of the AiGroup
business lobby, said the levy "will only serve to dampen our economy at a
time when we need growth". A one-off debt levy on "people who are
working, who are contributing to our economy, who are spending at a time
when our economy is already fragile, we think is deeply problematic".

So
what are you saying, Innes? Better to take money off people who don't
work - say, the elderly, the unemployed, sole parents with little kids?
People who don't work don't spend? People who spend don't contribute to
the economy? I'm not following you.

According to the Financial
Review, a senior Liberal figure, who did not want to be identified, said
the tax increase was not just a broken promise but poor economics and
an attack on the Liberal Party's base.

"We didn't vote for a
f---ing Abbott government to increase taxes, did we?" he said. Ah, do I
detect a note of self-interest creeping in among the high-minded concern
for the health of the economy?

Trevor Evans, of the National
Retail Association lobby, said the tax would reduce discretionary
spending and damage economic confidence. "A debt levy, even a temporary
one, on medium- and higher-income earners would damage consumer
confidence at a critical time," he said.

Great argument, eh?
Anything you don't like the sound of - especially since you and your
mates will be paying it - is a bad thing because you just know it will
wreck confidence. My old boss Vic Carroll used to speak with cynical
amusement about the "easily frightened fawn of business confidence". Do
anything business doesn't fancy and the economy will stop dead.

Speaking
as one who's been on the top tax rate since 1982-83 - when it was 60 cents
in the dollar, and stayed there for another three years - and escaped it
for just one year, 2008-09, when Peter Costello's salary sacrifice
superannuation rort was at its height, all this is self-serving rubbish.

Yes,
as a failed accountant I do keep a record of income tax I pay, though
it goes back only to 1969-70. And do you seriously believe being on the
top tax rate has discouraged me from working hard or aspiring to be editor?

Do
you think money's the only thing I get out of my job? Do you worry I
might quit Oz to be economics editor of The New York Times or The Wall
Street Journal? (Tip: not many vacancies in the Big Apple for people who
think they're hot shots from Down Under.)

Do you think being on
the top tax rate - and hence a pretty flash salary - has discouraged me
from saving much in the past 30 years? Do you think my obscenely
taxpayer-subsidised super payout won't be as big as a lottery win?

And
though all my fellow victims on the top rate don't get the ego reward
of having their opinions broadcast to the world, do you think senior
executives, people in financial services, city lawyers, medical
specialists and the like get no satisfaction from being a winner in the
socio-economic status race, or from having kowtowing underlings to boss
about?

As best I can determine from the leaks seeping under the
door of the Prime Minister's press office, Joe Hockey plans to impose a 1
percentage point tax levy on the part of individual taxpayers' earnings
that exceeds $150,000 - or maybe $180,000 - a year.

If so,
someone on $200,000 is facing a punishing tax increase of $500 a year,
or $9.60 a week. Really? That's what's going to destroy incentive, swell
the brain-drain and foster rampant tax avoidance, not to mention stuff
economic growth?

Estimates by Ben Phillips of the University of
Canberra point to about 650,000 people earning more than $150,000 a
year, making up the top 7 per cent of taxpayers.

If the threshold
turns out to be the higher $180,000, this would affect 400,000 people,
making up the top 4 per cent of taxpayers. (Note how quickly the number
of people affected falls as you move further away from the median
taxpayer's income of about $55,000 a year.)

What gets me in all
the propaganda above is the evidence the disease of fiscal monoculism
has reached epidemic proportions. This is the sickness that allows
people to see only one side of the budget.

A budget deficit, for
instance, can only ever be caused by excessive government spending,
never inadequate tax revenue. And though an increase in taxes would kill
consumer demand, equivalent cuts in government spending would have no
adverse effects. Can't see it, myself.

Wednesday, May 7, 2014

We will hear a few toned-down echoes of the report of the National
Commission of Audit in Tuesday's budget but, apart from that, the memory
of its more extraordinary proposals is already fading. For most
Coalition backbenchers, that can't come soon enough.

But I think the
audit commission has done us a great service. It has been hugely
instructive. The business people and economists on the commission
offered us a vision of a dystopian future.

It's a view of what
lies at the end of the road the more extreme economic rationalists are
trying to lead us down. If you've ever wondered what life would be like
if we accepted all their advice, now you know.

It would be a
harsher, less caring world, where daily life was more cut-throat, where
the gap between rich and poor widened more rapidly and where the
proportion of households falling below the poverty line increased every
year.

Ah, but think of the advantages: we would have fixed the
budget problem and started getting the public debt down without having
to pay any more tax. And that's not all: we'd be left with a much more
efficient economy.

Are the report's proposals the product of
self-interest or ideology? Fair bit of both. To oversimplify, the
business people would be motivated mainly by self-interest. They don't
tend to be big on ideology - at least, not the sort that's internally
consistent.

The economists, on the other hand, would be driven
mainly by ideology. When you study economics you're taught a simple
model of the way the economy works. It's supposed to be just a useful
analytical tool, but it tends to take over the thinking of those who get
jobs as practising economists. Those who become convinced the simplest
version of this "neo-classical" model holds an equally simple answer to
most economic problems, come up with policy recommendations just like
those in the report.

The self-interest in the report is easily
seen: it would fix the budget problem - and, don't be in any doubt,
there is a problem - by taking money from low income-earners and
middle income-earners, but not high income-earners.

The report
fits perfectly with a wry observation from John Kenneth Galbraith, as
paraphrased by the late John Button: "The rich need more money as an
incentive and the poor need less money as an incentive."

But if
you want to understand the ideology behind the report - what prompted
the economists on the commission to advocate the harsh measures they did
- you need to know a little about the strengths and weaknesses of the
simple neoclassical model that fundamentalist economists take as their
infallible guide.

It assumes that pretty much all you need to know
about the economic dimension of our lives is that markets work by
allowing prices to adjust and thereby bring the demand for and the
supply of particular goods or services into balance. Except in rare
cases, the main thing that would stop this process keeping the economy
in balance and working well is government meddling in the market.

So
the model predisposes those who take it literally to believe the less
governments do the better. Government needs to be as small as possible,
so if government spending exceeds its revenue from taxes, the only
acceptable answer is to cut spending to fit. To solve the problem by
increasing taxes would damage the economy.

The model is built on
various assumptions. One is that all of us are "rational" (hard-headed,
with perfect self-control), so we don't need governments stopping us
doing destructive things (such as smoking or becoming obese) or even
using payments to nudge us in the right direction. Indeed, we'd all be
better off if governments gave us more freedom (and thus didn't need to
make us pay so much tax).

Two other key assumptions are that we
all operate as individuals and that what makes the economy work
efficiently is competition between us. So the model casts aside the
possibility that we're social animals who identify with groups and like
acting in groups, even groups as large as "the community". Nor does it
have any place for the possibility that sometimes co-operation between
us gets better results than competition between us.

It assumes the
notion of "shared responsibility" - of using the budget to require the
well-off to subsidise the less well-off - could only discourage the poor
from standing on their own feet and so make things worse on both sides
of the deal.

This explains why the report's main savings come from
making even tighter the already very tight means-testing of access to
government benefits. It would abandon Medicare's most fundamental
principle of universality - treating everybody equally and paying for
the system via general taxation - to introduce co-payments and
means-testing.

The model further implies that the more aspects of
our lives that are run on market principles the better off we'll be. So
it advocates greater competition between public and private schools,
public and private hospitals, private health funds, universities and
private education providers (as well as among big and small unis) and
between rich states and poor states (South Australia and Tasmania).

It's
change that would move us from one person, one vote towards one dollar,
one vote. For those of us who have lots of dollars, what a paradise it
would be.

Friday, May 2, 2014

Don't be too alarmed by the startling proposals by the National
Commission of Audit. Few of its recommendations will make it into the
budget on Tuesday week. They were never intended to.

Ostensibly, the
commission wants to reverse the tide of a century of federal-state
relations, crack down on the age
pension while leaving superannuation tax concessions unscathed, reduce
Medicare to something mainly for the poor, hit middle-income families
and make the treatment of welfare recipients much harsher.

Don't
believe it. Truth is, almost all incoming Coalition governments have
commissioned commissions of audit since Nick Greiner used the tactic in
1988. What all the federal and state audit reports since then have in
common is that only a handful of their recommendations are ever acted
on.

That's not their purpose. Rather, it's to claim that the
previous, Labor government left the books in a terrible mess, thereby
justifying an initial, horror budget - all Labor's fault - and the
breaking of any election promises now found to be inconvenient.

In
this case, the audit report is softening us up for the budget by
raising the spectre of a much tougher budget than we're likely to get.
It's Joe Hockey getting ready to leave unsaid: See, I let you off
lightly.

Audit reports are never put into practice because they
are commissioned from worthies who make radical proposals no politician
hoping for re-election would ever implement. The cuts we do see in the
budget will have been worked up by the professionals: Treasury and
Finance.

This report's proposals go so far over the top - are so
impolitic, impractical and improbable - that today is the last you will
hear of most of its 86 recommendations.

What distinguishes this
report from its predecessors is the blatancy of its commissioning. It
comes from an "independent" inquiry effectively handed over to just one
business lobby group, the one composed of the most highly paid chief
executives in the country, the (big) Business Council.

Not
surprisingly, the commission found ways to solve our budget problem at
the expense of almost everyone bar the top "1 per cent" whose interests
the council represents. Speaking as a near one percenter myself, there's
little in its 86 recommendations that would make a dent on my pocket.

There's
little in the report's analysis of the budget problem that is new. Not
to anyone who had bothered to read Hockey's midyear budget review in
December, Treasury's budget review published early in last year's
election campaign or any of Treasury's three intergenerational reports.

Don't
be in any doubt: we do face a genuine and worrying problem with the
budget which, without unpopular measures, will remain in annual deficit
for years to come and rack up an excessive level of public debt. It's
not a problem yet, but it will become one and the best time to start
making tough decisions is now.

What's new - and dishonest - is its
claim that the problem is all on the spending side of the budget, whose
projected growth is "unsustainable". Its solution is to slash spending
that supports the living standards of low- and middle-income earners,
while arguing that asking high-income earners to chip in by paying
higher taxes is unthinkable.

It exaggerates the projected rapid
growth in government spending by focusing on the 15 biggest spending
programs, which happen to be the fastest growing, while ignoring the
many other programs, expected to grow much more slowly.

It turns
out total spending is projected to grow at the rate of 5.3 per cent a
year, while the economy grows at 5.1 per cent. That says there's no big
problem on the spending side.

In fact, the commission exaggerates
the size of the problem by adopting the arbitrary assumption that the
growth in tax collections is capped at 24 per cent of gross domestic
product. It justifies this by claiming the cap is needed to avoid the
evil of bracket creep, conveniently ignoring the scope for covering the
cost of limiting bracket creep by cutting the many tax breaks enjoyed by
the big end of town.

But none of this fiscal prestidigitation
says the budget will be a cakewalk. It will be the toughest budget since
the Howard government's post-election budget in 1996. Its bark,
however, will be worse than its bite.

A lot of its toughest
measures won't take effect until after the next election. And some of
its most unpopular measures are unlikely to make it past a hostile
Senate.